Purchasing Power Parity: The End of Deceptive Inflation Reports

July 23, 2013

For various reasons (ranging from political mismanagement to civil war to economic sanctions) some countries are unable to maintain a stable domestic currency. These "troubled" currencies are associated with elevated rates of inflation and, in some extreme cases, hyperinflation. Often, it is difficult to obtain timely, reliable exchange rate and inflation data for countries with troubled currencies, says Steve H. Hanke, a senior fellow at the Cato Institute.

Regimes in countries undergoing severe inflation have a long history of hiding the true extent of their inflationary woes. In many cases, governments fabricate inflation statistics to hide their economic problems. In the extreme, countries simply stop reporting inflation data. This was the case in Zimbabwe, a country that recorded the world's second-highest hyperinflation.

The Mugabe government stopped reporting inflation data in July 2008, when the peak monthly inflation rate was "only" 2,600 percent.

Unfortunately, these official July 2008 data are still used in press reports and by venerable institutions like the International Monetary Fund.

There is, of course, a "little" problem. The hyperinflation actually peaked at monthly rate 30 million times higher than the official peak inflation rate.

The true peak of Zimbabwe's hyperinflation occurred 3.5 months after the government's last release of official inflation data.

Many countries have followed this course -- failing to report any usable monetary data and neglecting to report inflation data in a timely and replicable manner. Those data that are reported are often deceptive, if not completely fabricated. Yes, official economic data from countries with troubled currencies often amount to nothing more than "lying statistics" and should be treated as such.

If free market exchange rate data (usually black-market data) are available, a reliable estimate of an inflation rate can be determined. The principle of purchasing power parity (PPP) (which links changes in exchange rates and changes in prices) allows for reliable inflation estimates during periods of elevated inflation.

Indeed, PPP simply states that the exchange rate between two countries is equal to the ratio of their relative price levels. Accordingly, to calculate the inflation rate in countries with troubled currencies, a rather straightforward application of standard, time-tested economic theory is all that is required.